Utility stocks have remained an attractive choice among income-seeking investors and those who have a low-risk appetite, as utilities generate stable earnings and offer high dividend yields. American Electric Power (NYSE:AEP), I believe, is a good investment stock for income-seeking investors for 2014. The company is expected to benefit from an expected recovery of industrial electricity demand. Also, the company is planning to incur aggressive capital spending and observe cost controls, which will drive its future earnings growth. Current valuations also remain attractive for AEP and it offers a healthy dividend yield of 4.3%, which makes me bullish on the stock for 2014.
AEP is among the high quality utility companies offering stable earnings and a decent dividend yield. An important reason that makes me bullish on the stock is its aggressive and clearer capital spending profile. The company plans to incur approximately $11.5 billion worth of capital spending from 2014 through 2016, which will result in earnings growth for the company. 95% of the planned capital spending for the next three years is expected to be directed towards regulated operations, which will increase AEP exposure to regulated operations, translating into more earnings stability. The company's planned regulated capital spending consists of $2.9 billion in regulated generation investment, $3.1 billion towards regulated distribution investment and $4.5 billion towards regulated transmission investment. Regulated capital spending of $10.5 billion is expected to result in a 7% rate base growth in the coming two years. The following table shows a further breakdown of regulated capital spending for AEP.
Percentage of Regulated Spending
Regulated Fossil/Hydro Gen.
Regulated Environmental Gen.
Transmission Joint Venture
Source: AEP's Presentation
Another reason for my bullish stance on AEP is its cost management measures. The company anticipates flat O&M for the next two years of $2.8 billion; maintaining O&M spending at the 2011 level. Consistent with its cost control measures, the company plans to improve its efficiency, which will result in approximately $90 million of additional revenues and $140 million in cost reduction, resulting in $230 million of additional annual pretax earnings. The following table shows the opportunities identified by the company to meet its cost efficiency plan.
Generation (including nuclear - largely related to competitive generation)
Source: AEP's Presentation
Dividend Cash flows
AEP is a good investment option for income-seeking investors, as the company offers a healthy dividend yield of 4.3%, backed by its solid operating cash flows. The company has been constantly increasing its dividends over the years, and has targeted a long term payout ratio of 60%-70%. Dividends offered by the company are sustainable, as it has a healthy dividend coverage ratio of 3.9x. The following table shows the payout ratios, dividend coverage ratios and annual dividends for AEP from 2009 to 2013.
Source: Company Reports and Calculations
(Note*: 2013 calculations are based on YTD financial performance and estimates. Dividend Coverage ratio = Operating Cash flow/Annual Dividend.)
I am bullish on AEP for 2014 and believe it is a good investment option for income-seeking investors. An impressive capital spending profile and cost control measures are expected to have a positive impact on the company's future earnings. Also, the stock is currently trading at a cheap forward P/E of 13.9x, in comparison to the utility sector's forward P/E of 15x, implying a 7.5% discount to the forward industry P/E. I believe the valuations remain attractive for AEP given its growth profile from 2014 to 2016. Based on my price target of $53, the stock offers potential price appreciation of 13.5%. Including the dividend yield of 4.3%, the stock offers total potential return of 18%. I calculated the price target of $53 using the forward industry P/E of 15x and AEP's 2015 EPS estimate of $3.47.